Monthly Commentary

SUMMARY
Mid Year Update


CHART UPDATES
YTD performance of various asset classes


YELLEN AND TRUMP
Hubris Abounds


SUMMARY OF INVESTMENT THEMES

MID-YEAR UPDATE

Investors these days have incredible access to investment information. In fact, I believe never before have people had so much information at their fingertips. I am sure many of you have your stocks, ETFs and fund tickers logged in to your iPhone or Samsung phone and can check them in real-time anytime you want. Additionally, you can see any news attributed to them at any point in the day. While this is an incredible feature, I believe it completely counteracts our ability to be long term investors. I think many investors realize that day trading against the machines is futile nowadays. The power and speed of the trading algorithms put in place by the largest investment firms are truly remarkable and have been very profitable to those companies. Individual investors cannot and should not compete against that power.

However, individual investors have one, single distinct advantage….time. Fund managers, financial advisors and institutions are often judged month to month and quarter to quarter. The “what have you done for my lately” question often daunts investment professionals. In my opinion, that pressure can lead to poor decision making by removing the major advantage individual investors have…time. Is ABC company really a substantially different company now than it was one month ago? I doubt it, but the stock price may have substantially moved.

I posit that from the perspective of the average individual investor out there, the huge volume of fragmented information often given in short soundbites presents quite a challenge. How best to implement everything while keeping the focus on the longer term? I continue to believe that a globally diversified portfolio with tilts toward value and momentum with an eye toward trend management is often the best way to construct an individual portfolio. But, like any approach, it can and will underperform and outperform at different times.

Very few investors can sit in a 100% stock portfolio through the “bumps” that are routinely 30%, 40%, 50% paper losses and come out the other side intact. By combining other assets such as bonds or alternative investments such as REITs, commodities and gold, one can potentially create a portfolio with less volatility where investors don’t feel as much of the effects of stock bear markets. However, those assets are not without risk as well.

While stocks often suffer sharp declines, bonds usually erode over time from the effects of inflation. Commodities, REITs and gold, often perform well with inflation but underperform in times of deflation or low inflation. (Investing in Real Estate Investment Trusts (REITs) involves special risks such as potential illiquidity and may not be suitable for all investors. There is no assurance that the investment objectives of this program will be attained.) The point I am trying to make here is that for the long term investor, having exposure to each of those asset classes can create a well-diversified portfolio that may provide a “smoother ride” to your goals.

I think it is important to semi-annually take stock of the returns in various asset classes, not every day, week or month but twice a year seems very reasonable to me. For all those you read and hear on TV that supposedly “know” where markets and assets are headed, beware. This “game” is about educated guesses.

I am reminded about some advice I received years ago. The most profitable investments are sometimes made at a time when you often feel like you are about to throw up! The more comfortable an investment seems to you, the worse it may end up being because all the “warm fuzzies” are priced in at that point. If you feel sick to your stomach when investing in something because it’s been doing so poorly, in the long term it could potentially end up being a great investment!

VARIOUS ASSET CLASS CHARTS YTD

 

U.S. Small Cap Equity up 6.8% YTD

All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

 

U.S. S&P 500 Large Cap up 10.7% ytd

All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

 

Emerging Market Equity up 19.75% ytd

All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

 

Developed Foreign Equity up 14.48% ytd

All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

 

U.S. Dollar down 8.19% ytd

All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

Gold up 9.3% ytd

All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

Gold Miners up 5.4% ytd

 

All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

U.S. 10 Year Treasury up 1.32%

All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

 

The NYSE Gold BUGS (Basket of Unhedged Gold Stocks) Index, also called the HUI Index, is a modified equal dollar weighted index of 15 major gold mining companies. The MSCI EM (Emerging Markets) Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of the emerging market countries of the Americas, Europe, the Middle East, Africa and Asia. The MSCI EM Index consists of the following emerging market country indices: Brazil, Chile, Colombia, Mexico, Peru, Czech Republic, Egypt, Greece, Hungary, Poland, Qatar, Russia, South Africa, Turkey, United Arab Emirates, China, India, Indonesia, Korea, Malaysia, Philippines, Taiwan, and Thailand. The MSCI EAFE Index is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US & Canada. The MSCI EAFE Index consists of the following developed country indices: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland and the UK.

 

JANET YELLEN'S PROCLAMATION AND MY NAIVETE'

The big news making its way around the investment community was Janet Yellen’s testimony and the following quote from June 27th. “Would I sawy there will never be another financial crisis? You know, probably that would be going too far, but I do think we’re much safer, and I hope that it will not be in our lifetimes, and I don’t believe it will be.” What is the significance of this bold display of confidence? Throughout history, statements like this from financial politicians are often made in times of complacency or before important turning points. They don’t occur when a crisis is fresh in our minds…people in power utter them at often the worst possible times. I am sure she was just trying to show confidence in what the Fed has done to distance ourselves from the last crisis, but it is interesting that she chooses now to make a statement like that.

I must admit, as we entered this year, following the “Trump bump” upward move in the stock market from his election, I had thought naively that with a Republican controlled House and Senate and a Republican President that we would see substantial tax reform and healthcare modification bills already proposed and passed. I think the market assumed some of the pro-business policies President Trump was floating would be enacted sooner rather than later. Putting aside his smugness and the countless organizations and citizens he has put off by his language and temperment, the one thing many people agreed with was that he could be an agent for economic change….for the better.

It turns out, in Washington it may just be more of the same, bickering and posturing. I naiveley thought after six years of lambasting The Affordable Care Act, the Republicans would have a very viable alternative ready to go that would easily make it through Congress. Boy was I mistaken….and maybe the markets are too. Word around Washington is that a tax bill of some kind will be presented in September with the hope of passing before Thanksgiving…..a full year into his presidency. The effects of such a plan would most likely not be felt until 2nd half of 2018. For now we continue to live and work with uncertainty. MY fear is that this uncertainty creates a significant slowdown in business activity that might showcase the instabilities still lurking in the financial system.

We have re-levered our economy and individual balance sheets to levels that are now higher than before the GFC (global financial crisis). In addition, this chart of Central Bank Balance Sheets shows just how bloated they have become after binging on quantitative easing for the past 9 years.

I just don’t believe these bankers will be able to reduce the balance sheet AND raise interest rates without having some sort of problem. If this occurs, watch the Treasury market….my guess is that should a problem develop, rates 10 years and out actually move lower from the current 2.35% level and potentially the 10 year approaches 1.25%. This isn’t my base case, but it very possible should the economy continue slowing and a Fed misstep occurs. Now may be a good time, after the 7.7% bond market sell-off to begin to look again at the Treasury Bond market for potential profits.

Here is a chart for perspective.

All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

 

Of course, if interest rates move lower, than bond prices move higher and therein lies the opportunity. You can see after the 7.7% decline it sure looks to me like we are seeing a strengthening in bond prices over the past 3-4 months.

All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

In my opinion, former Fed Chairman Bernanke believed he needed to begin raising rates back in 2013…but they didn’t. He tried and the “taper tantrum” ensued. The Fed knows they should have been raising rates and are now way behind. The beauty of government…or the beast of it is that many of the current Fed governors will be gone over the next year or so. This current Fed is probably going to raise rates a few more times, let some of its debt mature and ride of into the sunset. Fully responsible for any future problems related to this experiment but absolved of responsibility. According to John Mauldin, President Trump is going to have the opportunity to appoints at least six Fed governors in the next year. Who do you think will get the blame if there is trouble? It will not be Yellen and the current Fed. It is a no win situation for the next Fed President and the board of governors. They will be responsible for getting us out of the position the previous Fed got us into and will bear the responsibility.

Be aware of your portfolio risk. We cannot predict what will happen or when….but we can prepare. The best football teams often have a great defense. Portfolio management starts with risk management. Be careful of getting too far out over your proverbial skis. Look for opportunity and stay nimble. This is going to get interesting.

INVESTMENT IDEAS

  • Rather than trying to “beat the market”, focus on beating inflation and the rate on cash.  Plan for safety and liquidity while seeking positive returns.

 

  • Equity valuations are very rich but masked due to the distortion of the Treasury curve. Volatility is returning to the markets and I think long/short managers are best positioned to capture this volatility by owning companies with strong businesses, barriers to entry, and good valuations and selling short weaker companies with high debt loads that have risen sharply with the broad market rally. I think this strategy of hedged equity may have the potential to produce attractive risk-adjusted returns if and when investors begin to question the valuations of companies. Stock investing involves risk including loss of principal. No strategy ensures success or protects against a loss. Long positions may decline as short positions rise, thereby accelerating potential losses to the investor.

 

  • Monsoon country investments. Attempting to take advantage of demographic, educational and investment possibilities in the countries surrounding the old spice routes of the Indian Ocean. International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. These risks are often heightened for investments in emerging markets.

 

  • A potential U.S. infrastructure upgrade cycle may be around the corner. Moving from our current grade of D+ to B would require an investment of $3.6 trillion by 2020.

 

  • Supply problems remain high across the energy asset class. While there isn’t a current shortage of energy on the planet, it is taking more and more energy and capital to discover, drill, transport and refine it. Long term Demand should continue to grow globally, particularly in China, India, and other developing countries.

 

  • Potential food shortages due to inclement weather and higher demand from the emerging Asian middle class could result in a boon to agricultural land and potash fertilizer companies. International and emerging market investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors.

 

  • The rise of E-Commerce has coincided with an increased desire for efficient warehouse distribution real estate. As e-commerce moves toward even faster delivery, positioning of distribution becomes even more important.

 

  • Precious metals mining companies have been extremely beaten down over the past four years. Mining is an industry that spans hundreds of years. Companies that mine for commodities are often highly cyclical, meaning they have sustained moves both up and down. When investing in the mining space it is important to be a contrarian. Ideally, you would want to accumulate miners when sentiment is poor around them and sell them when sentiment is positive. Historically this has been a good strategy.

 

No strategy ensures success or protects against a loss.

If you haven’t followed me on LinkedIn make sure to connect with me. Since the beginning of the year, I have been a contributor to many major investment publications and it has been great getting to know some of the writers.

 

Check out my appearances by clicking here

 

Have a great rest of your summer and will release my next letter in September after Labor Day.

Regards,

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Colin B. Exelby
President
Celestial Wealth Management

 

 


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